We Study Billionaires - The Investor’s Podcast Network - TIP287: Value Investing and Market Cycles w/ Vitaliy Katsenelson (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's show, we have Vitale Katz-Nelson. Vatali is the chief investment officer at the Investment Management Associates. He has written two books, one titled the Little Book of Sideways Markets and the other titled Active Value Investing. He's often featured on Bloomberg, Business Week, Barrens, and the Financial Times. I think it's very important to note that this conversation was recorded more than two weeks ago, and as everyone knows, things in the markets have become quite crazy with national shutdowns and unprecedented volatility. With that said, many of the ideas that Vitaly talks about are relevant for how to think about managing risk and preparing for many of the things that we've seen happen since the

Starting point is 00:00:39 recording took place. So without further delay, here's our conversation with Vitali Katzenelson. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Hey, everyone. Welcome to the Investors podcast. I'm your host, Preston Pish, and as always I'm accompanied by my co-host, Stig Broderson. And we're really excited to have our guest here, Vitale, Katzenelson. Vitali, welcome to the show. Excited to have you. It's my pleasure. We're talking about your book, the little book of Sideways Markets, and I thoroughly, thoroughly enjoyed reading your book. I think you have some amazing content in here.

Starting point is 00:01:34 you have some amazing principles in here for people that are especially getting their feet wet in financial markets. But what's difficult is in the past decade, we have had anything but a sideways market. We've had an aggressive, somewhat even define it as an insane bull market. So when we look at where we're at today, I think if you went back into the 2005 timeframe and you were looking back then and interest rates were 5 to 7% back in that time frame, everything appeared to be somewhat normal. And from a valuation standpoint, the economy was operating in somewhat of a normal manner.

Starting point is 00:02:18 Today, and literally since the economic crisis back in 0809, they've kept interest rates at 0% were literally at the top of a credit cycle. So when you're looking at that and you're looking at the valuation, of how that makes all other assets get priced with zero percent interest rates. As a value investor, how does a person move forward in this kind of market and continuing to use those crazy discount rates? Reasonably, I guess, is the question that I'm looking at, because I'm like you, I'm a hardcore value investor.

Starting point is 00:02:52 And I'm looking at these macro themes that we're being faced with. And I'm saying, is this all going to change? How is this going to change? because it's all a function of inflation. So I guess I'm kind of curious just how you see the current market conditions as a value investor. Yeah, so it's kind of interesting.

Starting point is 00:03:08 For a long time, value investors felt that they don't have to pay much attention to the macro, right? Because you could be kind of blissfully ignorant because everybody looked at Buffett and Buffett said, well, it doesn't matter what Federal Reserve does, et cetera. Well, there was a problem with that

Starting point is 00:03:26 because people miss, first of what, misunderstood Buffett. But Bopit would basically say his decision making would not change even if he knew what the Federal Reserve would do six months from now. But at the same time, Baffett wrote an article in 1998, if I remember right, about how the dollar was too strong and it's going to get weak, really talking about macro stuff. So Baffett did pay attention to that. However, Baffett was not trying to be a weatherman, trying to predict what the weather is going to be six months from now, but he was more like a climatologist.

Starting point is 00:03:58 looking at the big events, climate-changing events, and trying to adjust his portfolio decisions based on the risks and, I guess, in opportunities, he would see from those climate-changing events. So my point is this. As an investor, value of any asset is a present value of future cash flows. But those future cash flows in your analysis will be influenced by what's going on in the world around us. It's becoming more and more complex every day. and it's becoming more, more mutated by what's going on in the global economy.

Starting point is 00:04:31 If you look at our economy, our earnings were basically flat last year. So our economy grew 2% real growth, 4% nominal growth, which is not horrible, except we usually grow 3% real growth, except our debt is now over 100% of GDP, and our debt grew 5.6%. In other words, to produce this 4% number, growth, they had to borrow 5.6%. And so the stocks went up 30% last year, even the earnings were flat. If you ask me why the stocks went up last year, usually my answer would be, I have no idea. But I think the reason they went up because interest rates declined. So this is our economy. Then you look at

Starting point is 00:05:11 China, but China probably is experienced one of the biggest bubbles, financial bubbles in the world's history. If you look at how much debt went up over the last 10 years, et cetera. So China has its own problems. It's a financial system is one prick away from having a very good moment. And then you can look at Japan, and Japan is, again, it's an economy that's where its population is shrinking, its debt is growing, and it's the most indebted developed nation. And then you have Europe, of course, which is kind of a union of countries that kind of don't want to be together. It's kind of dysfunctional marriage of 20 plus countries. But anyway, my point is this. As a value investor, you look at this picture and you say, it doesn't look this great.

Starting point is 00:05:51 and how this is going to play out? Well, I really have no idea because I can make a case for high inflation and it can make a case for deflation. And as a value investor, I say, I want to position my portfolio for the environment where it can survive anything, what I call a kind of all-terrain portfolio. And you have to be a little bit humble because one of the mistakes people make today is that they take a point of view that they're going to have inflation or deflation. You're going to have high interest rates or low interest rates. And take this binary view and they position their portfolio accordingly. If they get that right, they're going to make a lot of money. But the problem is the cost of been run of either outcome is too high. So as an investor,

Starting point is 00:06:37 what I'm trying to err on the side of create a portfolio that would do well either in inflation or deflation, high interest rates or low interest rates, that means my portfolio is going to be suboptimal if one of the extreme outcomes happens. But at the same time, I will still define in a, either outcome or still define, just won't make as much money if I just bet on the binary in that outcome. It's interesting that you would say that once you start to identify which trend that is emerging, then you can adjust your very defensive position that is more harmonious with a more inflationary or a deflationary outcome. Yes, I'm probably going to have to make changes as time goes by, because at that point I'll have more data to make this. Today, I have no idea.

Starting point is 00:07:20 So when you look across the globe and you see the trend of the bond market since 1981, it has not been hard to be a successful trader since rates have gone down, which has pumped up the value of bonds. And now we're approaching zero percent interest rate in the U.S. In real terms, meaning you subtract inflation, you're already at negative rates. And many other places in the world, including Europe, you have been a negative rate for quite a while, now. So I'm with you because if you do get more inflation, all of that unwinds so abruptly. So I'm kind of curious how you're thinking about positioning yourself in this defensive way when you talk about both a scenario with inflation and deflation. What would a stock look like

Starting point is 00:08:01 that is suitable for either of those outcomes? High quality and you would be looking for a significant margin of safety. When I say quality, what does it mean to us? It's kind of the broad buckets. It's a great business, great balance sheet, and great management. So what does great business mean? It's basically you have a company that have a significant competitive advantage, has high recurrence of revenues, has high return capital, which usually comes with competitive advantage, balance sheet, and that will be kind of a function of company's business as well.

Starting point is 00:08:34 But if company has a very strong competitive advantage, you can afford to have a little bit more debt. but if lower competitive advantage, you need to have the balance of it needs to overcompensate for that. And when it comes to management, we're really looking for two things, how well they run the business and how well they allocate capital. And those are two separate analysis because one thing I found is that when you own a large company, the biggest impact management has actually not in how they run the business. Because usually when you have a large company, you already have a lot of layers of bureaucracy. So management can't have an impact on it.

Starting point is 00:09:11 But the biggest leverage they get, actually, when they make an acquisition that adds or destroys value, because you can make that acquisition as a strike of a pan. So I really, ideally, I'd like to own a company where management owns a lot of shares, because at this point, we are in the same boat. So that's quality. And then you need to have a significant discount to fair value

Starting point is 00:09:31 because coming back to sideways markets, at some point, the P.E. Pendulum was in the other way. And when it does, the relative valuations company was used to trade at 45 times earnings, now traded 30, there's absolutely no reason why it can't go from 30 times earnings to 15 or 10. And when that happens, it's going to be very painful for those investors. And one extra point I want to make, I feel like it's a public service announcement for investors today. You have a lot of investors who are buying basically high-quality companies where they buy them solely

Starting point is 00:10:06 only dividend. Like, I'll give you a few names. If you look at Coke, Coke is trading 26 times earnings. This is a company that's barely growing. It has a lot of headwinds because people switch from sugary drinks to water, which is almost free. And it's traded 26 times earnings, but the only reason people are buying it because 3% dividend yield is better than 1.6% whatever the 10-year treasury pays. And people look at that yield and say, well, Coke is not going anywhere, and therefore it's better than treasury, except they start treating coal. Coke as a bond. But see, the problem is bond is a contract. In that contract, you know that the power value is 100 and you know unless the company defaults, you actually know exactly how much money

Starting point is 00:10:48 you're going to make. With Coke, the price is not a bond. Price is going to get a different interested environment. It's going to get revalued. And so there is absolutely no reason why Coke cannot start trading at the return time earnings. Again, the company is barely growing. And so you end up, if you are buying a code because you're getting 3% dividend yield, you may feel good except until we realize you just lost 30 or 50% of your money when the stock price decline. So that's something that worries me. So whenever you say that you're also looking for a company with a great balance sheet, are you talking more in terms of the idea that the assets listed on the balance sheet have an enduring

Starting point is 00:11:32 competitive advantage or are you talking more from a number standpoint? I'm kind of curious to hear your thoughts on how you're looking at the balance sheet. So when I talk about the assets, I usually look at the, this almost kind of touches on a price to book, those metrics. So I spend very little time looking in the balance sheet and looking at the what's the book value of the company, unless I'm looking at the financial company. The only time kind of the balance sheet from that perspective on the asset side of the balance sheet matters and the price to book matters is when you look at the financial company. But today, when I look at the balance sheet from defense perspective, I'm really looking at how much that company has, or a lot of times of balance sheet liabilities. So that's

Starting point is 00:12:12 how I look at balance sheet. When we look at companies, for instance, I'll give an example. We look at how the maturity is staggered. Can the company pay off that maturity from the cash that has in a balance sheet or from its cash flows? So when I look at the balance sheet, spending less time on assets, but spend a lot more time on liabilities. So, Vitaly, let's talk about growth. In your book, you have a quote by Warren Buffett. Growth and value investing are joined at the hip. And I love this quote because, especially new investors, look at growth and value as completely

Starting point is 00:12:44 different concepts and categorize other investors as either value investors or growth investors. In your book, you talk about how value and growth do go hand in hand. Could you please elaborate on that for our listeners? One of my favorite quotes is there is value in growth. Just think about it. Again, present value of any asset is a present value of future cash flows, right? So if companies grow in cash flows over the time, so the growth has a value. From analytical perspective, the way when we analyze companies, we spend very little time

Starting point is 00:13:17 looking at the next year's earnings, but we always look at earnings 45 years out. And we also do discounted cash flow models. But the reason we always look at earnings 45 years out and then discount them back, because then if company has grown business, so then we actually, then we capture the growth in our analysis. So the problem is, and this is very important to understand as well, that growth is valuable, but it's not priceless. Okay, this is very important to understand. In the environment when interest rates decline from 6% to 0 to negative, actually, if you think about it, it's almost a relationship of growth, again, companies who are growing earnings very fast,

Starting point is 00:13:58 the larger portion of the value lies in the future. Companies who are growing earnings at a slower rate, and more of the value lies in the present. So if you think about it for a second, this is really a relationship of a long-term bonds and short-term bonds, right? Long-term bonds, when interest rate declined, they have long duration, and therefore they go up a lot. Short-term bonds go up less.

Starting point is 00:14:21 Okay. So in today's environment, when interest rates declined and became negative, company that are growing very, very fast, they went up a lot. And I see a lot of investors of respect. Now they own these companies that trade at incredibly high valuations, even for growth companies, even if you value their future growth. And they find ways to justify these high valuations. And the problem is that the narrative becomes, these companies are so great than they are,

Starting point is 00:14:50 and they're growing earning so fast than they do, that we can justify almost any valuation. And I think there will be a price to pay for that. So this is where you say growth is valuable, but it's not priceless. And I think that is a key, I wouldn't understand. Because today you have a lot of companies that trade at 20, 25, 30 times revenues. And it's become a new normal. What used to be 25 times earnings was high. Now we have 25 times revenues and it becomes okay.

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Starting point is 00:19:05 Shopify, and start hearing... Sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify. dot com slash WSB. All right. Back to the show. I think for anybody that's hearing that, they're saying, how do we know when that

Starting point is 00:19:30 transition happens? Because if we would have been saying this five or six years ago, well, we would have missed out on 100% upside based on how the markets move because the markets continue to bid this. And so although you're 100% right that the realization is going to come, how do we know that the realization is going to come in a time frame that makes sense to continue to exercise such a strategy? And I know that this is an extremely difficult question, but it's a question that everyone that's listening is probably thinking. Well, I think anybody who listen to

Starting point is 00:20:02 this podcast, I think actually I have a simple answer for you. If you can figure out what the interest will do over the next 10 years, then you can either embrace or ignore what I told you. Because if the new treasure goes to zero and then goes to negative, I just did a great disservice to you. Because if you took anything I told you seriously, you probably would have made so much more money, just ignoring it. If interest rates start going up, or, and this is an important point, or we go into significant deflation, there are so many different combinations how bad things can play out. Because if you look at the global economy, we've been stretched so much by the amount of debt we have today. So you can have a deflation in negative interest rates, you can have a deflation and you can actually have interest rates go up a lot.

Starting point is 00:20:46 So there are so many ways the bad things had happened. But if bad things start to happen, then the message I'm giving you is actually a lot more valuable. But if you continue to have this kind of benign environment and interest rates to go lower, then you listen to me, I just did a disservice to you because you would have made so much more money, just not caring about risk and just continue what you were doing. when you see a bridge that's built on sand, do you really want to try to figure out which truck is going to be the one when it goes over the bridge that's going to topple it? Or should you just say, okay, we have a bridge that is unstable, and therefore we should operate under assumption that at some point it's going to topple?

Starting point is 00:21:25 So I am not trying to figure out what's going to do our economy in, what's going to cause the price turnings to decline, etc. I'm just trying to operate as if it's happening. I'm expected to be wrong for a long time until I'm right. But that doesn't mean that I'm not making money. It just means I would be taking less risk, probably would be making less money who somebody took more risk. And at some point, I'll be rewarded for not taking excessive risk.

Starting point is 00:21:51 And I think that is the important thing that people don't talk about. When you invest, it's both the yield you capture, but it's also the associated risk you incur. Year can be measured, but risk can't. The investor with the highest return in one year is not necessarily the best in the investor, he might just have taken the biggest risk. In 1997, if you were concerned about market's valuation and the exuberance, then you would have been wrong because it continued to 98 and 99. And then it blew up only three years later into Southern.

Starting point is 00:22:21 So if you were speculating in the stock market in 99, you were making a lot of money. And people like me and you would be making money, but not as much. And Buffett wasn't making much money. And then those people would look at us and say, well, this guys don't understand it, etc. And then when things will blow up, you realized that the risk they took showed up in the reference. A lot of people lost 50, 70% of their money where a rationality came back to value investing and Buffett was up in 2000 to sell in the thousand money, if I remember right. One point I want to stress, and because I don't want people to misunderstand me, I'm not saying

Starting point is 00:22:54 you should time the market. What I'm trying to tell you is that investors should be valued individual stocks. And in that process, that's how a portfolio is created. And the amount of cash you have in your portfolio is byproduct. Can you find high quality companies that are undervalued or not? And if you can, you're going to have more cash. And if you can, you're going to have less cash. And by the way, and this could happen in the market. You can be fully invested in the market that's making your highs if you are some parts of the market that are blowing up or it will be ignored. Or if you look globally. And I think that's the luxury we have today. We don't have to just look for stocks in the United States anymore. And in fact, if I look at my

Starting point is 00:23:32 portfolio, probably two-thirds of the buys that made of the last six months came from outside of the United States. You know, Meb Faber is really big on international value investing. He talks about it a lot, looking at PE ratios and other countries that have fantastic PE ratios, but aren't necessarily countries that people in the United States are comfortable investing in. So I'm kind of curious to hear a little bit more about how you view this as well. So when I invest in Europe, I almost feel as comfortable there investing in the United States. If I start venturing into countries where I may or may not feel comfortable traveling to,

Starting point is 00:24:11 then your position sizing should be so much different because the rule of law there is not as strong. You may wake up and find out that the company you thought you owned, you don't own it anymore. So I think the allocation to those countries would be lower and your position sizes should be lower because of that embedded risk. Again, in my mind, when I look at Russia, there were a few instances when investors woke up and discovered that the stocks they own, they don't own anymore because what government did or because they were minority shareholders. But if you take small positions, then you're probably going to be fine in a portfolio context. So one of the concepts you're big on is predictable earnings. Can you please define what that

Starting point is 00:24:49 is and how we can apply the concept for an investment strategy? When you look at predictable earnings, it should be a very commonsensical way of doing it. you should really try to look at it and say, is that the business that would have a predictable earnings? And this really comes from understanding of the business. So if you look at the home builder, I don't even have to look at the company's income statements to tell you that business would not have predictable earnings, right? If I look at company that basically the nature of the product that has a high recurrence of revenues, then that company generally would have very predictable earnings. Because, I don't know, if you take a company like Beckton

Starting point is 00:25:26 Dickinson, you take almost any pharmaceutical company. This company is because the demand for its products is economically insensitive, and because people have to take their product, it's going to have very high recurrence of revenues. Therefore, earnings are going to be predictable. Obviously, when you look at pharmaceutical companies, the predictability could be interrupted by patents expiring, et cetera. But the good thing about it, you can actually know exactly the way it's going to happen for the most part. But when you look at financial statements, we basically look at what the revenues did during the financial crisis, during the recessions, and that tells you, that's another way for you to find out how economically sensitive the

Starting point is 00:26:03 businesses. And you look at companies' cash lows and you see how stable the cash laws are, etc. Those are kind of the little financial tricks. But I think at the core is really, it just use your common sense. If you look at the business, you can actually figure out, if you look at defense companies, right, our defense spending only continues to go up. So that's a very high recurrence of revenue. So I don't have to even look at financial statements to know that these companies will have very stable earnings and cash flows, etc. So Vitaly, I'm kind of curious. What is an opinion that you have today that is unpopular that you think a lot of people would disagree with you on?

Starting point is 00:26:42 I think that the fan stocks, the market looks at basically fine stocks, because they can continue to grow at very high rates for a long period of time. And I would argue they can probably grow at a rate at above GDP growth rate, but probably the growth rate is not as high as the market expects. And I would say part of my argument would be is that growth has been fueled in part by what you and I talked about, which is accesses in financial markets. Because the venture capital market, the kind of accesses and zero interest rates are fueled. I would argue bubble in a venture capital market, which these companies have benefited from, if you think about for a second, if you are, I'll give you this analogy from 1999 era.

Starting point is 00:27:31 Cisco was a great company. It had a competitive advantage. It dominated the router market, et cetera. But Cisco has benefited from dot-com bubble, not just because of its valuation, which was incredibly high, but because a good chunk of its revenue came from customers that were dot-coms. They did not have sustainable business models. And so when the 1999 bubble blew up, Cisco actually suffered because a lot of its customers went away.

Starting point is 00:27:58 And consequently, its valuations suffered as well. And I would say, if you look at Google today, its valuation is not as high as Cisco's was in 1999. So that's not the analogy. The analogy is that a good chunk of its growth came from startups that were given money by venture capitalists and said, grow. Okay, and the way you grow a company like that, you basically, some of that you spend engineer, some of that you spend on Google, try to acquire customers.

Starting point is 00:28:27 And when the only objective is to grow revenues, and at that time, it's not even relevant to what's your customer acquisition cost is because you're willing to lose money as slow on as you can grow revenues, then you will be involved in uneconomical spending. And I would argue that things in general have benefited from that. And as this market becomes more rational, we're probably going to see slow, down and growth rate for these companies. And I think markets still does not expect that. So that would be my kind of unpopular. Warren Buffett is famous for saying that he doesn't look at macroeconomic events and predictions when he invests. He was specifically asked about this after this

Starting point is 00:29:06 dreadful week where stocks were slant almost 15% in late February. And he said, and I quote, you don't buy or sell your business based on today's headline, end quote. And this was when he was specifically asked about the impact of the coronavirus. How much do you look at macroeconomic events when you invest? Seth Claremont said, we worry macro and invest micro. So when I put my worry macro head on, coronavirus may end up in a big deal in the short term. and it may have a big deal in the long run for a different reason. In a short run, it's not just about what happens to consumption in China,

Starting point is 00:29:49 but also our global economy is so efficient and well-tuned to be just-in-time economy that in China is so important in global supply chain that I think these numbers are as accurate or inaccurate as newspapers they report, but there's 400 to 800 million people and it's some kind of lockdown. And this in the country that produces a lot of components that are going to global goods. So just that in itself, and we saw this numbers with Apple already, that's going to interrupt a lot. That's going to have a significant impact on the economy if it continues.

Starting point is 00:30:26 And then I read somewhere, demand for cars in China declined, I don't know, 90% or something. And again, I don't know what to believe this numbers or not, but to me, it's common sensical when people around you are dying from a virus. buying a car is probably not the first thing in your mind. So I don't know if that number is right or wrong, but directionally, it's probably right. One thought I have about the coronavirus and actually relates to the trading dispute, United States and China had. I think U.S. companies are waking up the fact that they should probably have less efficient

Starting point is 00:30:57 supply chains, and they should probably have more diverse number of trading, having factories in more countries than just China. And while country that should probably benefit from all this is India, because if you are trying to diversify your supply chain, this is another country that has one billion people. And India does not have the infrastructure as efficient infrastructure as China has, but maybe capital inflows could change that. This is a brand new thought for me, and I haven't done anything about it yet. But one thing I realized, our economy was too efficient. It was too, we kind of, the global trade, the global trade was coming alone for so long and so well. And we haven't had any interruptions of really much of interruptions, maybe had some,

Starting point is 00:31:46 it had tsunami in Japan, these kind of things. But there was very short-term interruptions as we become more nationalistic. And this has happened globally. I think it is going to happen that you're going to start seeing companies moving factories from China to other countries, and maybe India will benefit from that. But today, as an investor, what am I doing today? We doing a lot of homework, continuous companies or companies that will get disrupted in the short run because of coronavirus in kind of preparing a buy list.

Starting point is 00:32:16 I'll give you a group of companies. One of the obvious choices would be companies that are great businesses like online travel agencies. They are phenomenal businesses, but they're always expensive. We are preparing a list of them because global travel is going to get done. disrupted by what's happening in China. And actually now in other countries. And so we are hoping that these companies will decline. It doesn't mean that hope the coronavirus gets worse. Please don't get me wrong. That's not what I'm saying. But I think as companies start reporting their

Starting point is 00:32:44 numbers, investors will start to realize this is actually real. And we may get an opportunity to buy those. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up. And customers now expect proof of security, just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC or running an enterprise GRC program, VANTA keeps you secure and keeps your deals moving. Instead of chasing spreadsheets and screenshots, VANTA gives you continuous automation across more than 35 security and privacy frameworks. Companies like Ramp and Riders,

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Starting point is 00:36:08 slash income. This is a paid advertisement. All right. Back to the show. I think your comment on the just in time supply chain, because I mean, this is a fundamental that's taught worldwide at any business school is how do you optimize your supply chain? And it really kind of comes down to the variance of the arrival of the supplies and then just trying to optimize the living heck out of that inventory that you're sitting on. And so any company that's trading at a market cap above $50 million probably has a very aggressive just-in-time supply chain so that they're not sitting on a bunch of inventory. And since this has become so

Starting point is 00:36:50 systematized in our economy, we haven't seen a shock like the potential that this has, in my personal opinion. And I think when you start going into some of these issues of just in time supply chain management, it is going to be very different. What an interesting topic like you. I feel horrible for all the people's health and livelihood that this is impacting. And unfortunately, I'd like to say that I think that the trend is not going to get worse, but all the numbers are suggesting that it is. So it's going to be interesting to see how this plays out moving forward. I have a six-year-old daughter and she had a fever last week and we went to doctor and doctor says, well, she has a virus. My God, what if it's coronavirus? She did not have coronavirus.

Starting point is 00:37:35 But just the thought of that, just the fear that can have engulfed me. And I realized that, my God, this is what's happening in the rest of the world. And as a human being, I just, I really hope it doesn't lost this loan, and all my fears about this are overblown. About the supply chain, one of my favorite books is Nassim Talib's anti-fragile. And there he talks about if economists designed a human being, that means, we would have one kidney, because who needs two? It's inefficient. And I feel like if you look at the global economy, it's kind of to date, has been designed by a lot of economists, right? Because right now we have one kidney. And a company is waking up, if you probably need maybe two or three, yes, it's going to be an efficient, et cetera. But in the

Starting point is 00:38:22 short run, there are inefficiencies, but in the long run, it makes our business a lot more predictable and stable. And I think that's where we're going. Vitaly, I'm sure people are listening to this interview are as impressed with you as we are. Please give our audience a handoff to where they can learn more about you. So my articles can be read at contrarian eG.com. However, if you're listening to this podcast, you probably like to listen. So we have audio articles and it's an intellectual investor or if you go to investor.fm, basically my article is read to you.

Starting point is 00:38:55 Again, contrarianage.com and investor.fm. Well, Vitale, I can't thank you enough for making time out to chat with us. I thoroughly enjoyed reading your book. Like I said in the intro, some great principles for investors to think. about when they're going through this. And we've experienced just a wild decade. Sometimes the best position to be in is to just do the exact opposite of what everybody else is doing. So your principled ideas that you talk about in your book are really, really good for people to reread, to understand as some of these transitions might be on the horizon. So I just thank you

Starting point is 00:39:31 so much for coming on the show today. Thank you, guys. Okay, guys, so for this segment of the show, we'll play a question from your audience. audience and this question comes from Bruce. Hi guys, my name is Bruce. I am a huge fan of the show. Thank you so much for all you've done. I think I've learned so much more on this show than in school and I have a few university degrees. So thank you again for this. My question is about compounders. We're taught as disciples of Buffett to look for these great businesses at fair or cheap prices if possible. But I'm wondering,

Starting point is 00:40:08 Why we are doing this because most retail investors, and by retail investor, I mean somebody with less than a billion dollars, should be looking for doubles. Am I not right? I mean, shouldn't we be looking for businesses that are going to double quickly within a year and then flip, move on? That's how Buffett did it, if I'm not mistaken. Would we be not wiser to focus on Buffett's partnership letters, read those deeply, and try to understand what it was he did to get to the point where he then had that problem of how to

Starting point is 00:40:44 compound my huge wad of millions. Curious to hear your thoughts. And thanks again for all you do. I think that's a great question. I'm currently rereading the essays of Warren Buffett by Lawrence Cunningham and it's a highly recommended read. Now in the book, Buffett specifically addresses your Christian, so I wanted to mention it here. And what he said was that it is possible to get higher after-tax returns going in and out of the market compared to the strategy of having compounders, which you also refer to. And this is especially true if you have small sum of money to invest for. Now, he says that the reason why compounders are such a great strategy for him is, and I quote, we have found splendid business relationships

Starting point is 00:41:32 that are so rare and enjoyable that we want to retain all that we develop, end quote. So, what does that mean to us? As you mentioned, investors with less than a billion dollars. We are in a very different situation. And in contrast to someone like Warren Buffett, we typically don't have a relationship with the management. Now, I personally buy compounders instead of what you refer to as doubles for two reasons. The first one is that the long-term capital gains tax is 50% in the US, but I live in

Starting point is 00:42:05 Denmark and the tax rate is 43%. so it's very expensive to move in and out. But even so, even if I could pay the same lowest tax rate as you do in the US, I don't think I would change my strategy. Because finding doubles and buying and selling at the right time is just very, very difficult. And not only because you get penalized with taxes, but you also pay commissions, spread, et cetera, whenever you trade. So for me, I just found it easier, if I can even use that word, to invest in compounders than so-called doubles. The strategy comes with a lot more stress, too,

Starting point is 00:42:40 that is just not suited for my personality. Compounders are typically easier to find, but it's also easy for other people, so the trick is rather to find them at a good valuation. And if you compare that to two of my long-term positions, Berksie Halli and McKell, I would say that I would have a much easier time determine the intrinsic value,

Starting point is 00:43:00 and I can buy the dip while they continue to compound the intrinsic value for me. And so whenever I specifically mention those two picks, I think most people would agree that they are great business. That is not hard to identify. It really does come back to the valuation. So to answer you a question, yes, measured in stock return, it would be better to find doubles if you are a great stock investor. But if you're more humble about your skill set, and I'll put myself in that category,

Starting point is 00:43:28 compounders would on average be a better strategy for you. So, Bruce, one of the things you have to think about is these companies that do these 2x or 3x type returns, typically, typically speaking, have a smaller market cap. When you're dealing with something that has a smaller market cap, it also has a lot more volatility risk and it also has a lot more risk from a competitive advantage standpoint. So these smaller businesses, if someone wants to compete with them and take up a substantial portion of their market share, that can happen. And it often does happen in that. startup or small cap space. So where I think it gets tricky is a lot of people that read Buffett's earlier stuff, you got to understand his age, you got to understand his risk tolerance at that point in his career versus where he is now as a person who has a legacy and has a just ridiculous amount of cash to move around and can only really funnel it into highly capitalized, massive businesses that aren't going to be able to pull a 2x in a year. So that's where I think some of it kind of breaks down when you're looking at those timelines

Starting point is 00:44:38 and you're looking at the change in his investing philosophy, not only because of his age, but also because of the capital that he has. And then also the legacy and responsibility that he holds to all those shareholders to make sure that he doesn't lose their money. So I think those are some of the factors when you're specifically studying buff it on your strategy. Now, if your risk tolerance is very high and you're comfortable and you feel like you understand the sector and you want to go in there and put some of those highly volatile type positions on, have at it. I think that it's something that you can only

Starting point is 00:45:14 answer that personally for yourself. And I would say this to you. If you have a company that just went 2x and it's because they developed a new product or service that's revolutionary in that field of business, it might go 10x in the coming two or three years, especially if it was a smaller cap type company. That kind of stuff can happen. So it's really important that if you start getting these big gains on something, you're not looking at it from, I made a bunch of money said, let me take my money and run. You're looking at it from an owner's standpoint. As a business owner, you have to understand your competition that's going to come in and potentially take your market share. You've got to understand your product and what kind of

Starting point is 00:45:56 moat there is around that product or service. And if you can answer those questions and you understand what those are, you might want to keep holding even if even if it's gone up 200, 300, 400 percent because you understand your business as an owner. So I would highly encourage you to think from that mindset and not be too quick to maybe cut some of your large substantial wins as well. All right. So Bruce.

Starting point is 00:46:20 For asking such a great question, we're going to give you free access to our intrinsic value course for anyone wanting to check out the course, go to tip intrinsic value.com. That's tip intrinsic value.com. The course also comes with access to our TIP finance tool, which helps you find and filter undervalued stock picks. If anyone else wants to get a question played on the show, go to asktheinvestters.com, and you can record your question there. If it gets played on the show, you get a bunch of free and valuable stuff. All right. So before we let you go, remember to check out a new feed with bonus episodes how and why Preston and I started TIP, the business model behind TIP, and Tobias Kyle Ler even drops by in Pitt's Southwest Airlines. You can check out all of our bonus episodes

Starting point is 00:47:05 on theamasterspodcast.com slash extra. That is the amassterspodcast.com slash extra. Or you can check out the links that we included there in the show notes. But guys, that was all that Preston and I had for this week's episode of the Amherstas podcast. We'll see you guys again next week. Thank you for listening to TIP. To access our show notes, courses or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional.

Starting point is 00:47:35 This show is copyrighted by the Investors Podcast Network. Written permissions must be granted before syndication or re-broadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP287: Value Investing and Market Cycles w/ Vitaliy Katsenelson (Business Podcast)

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